MANAGER PROFILES Series features: Eric Munson, Chief Investment Officer, Co-Founder, ADIT Ventures

(Click image to play video) In this episode of the Manager Profiles series, Eric Munson, Chief Investment Officer & Founding Partner of ADIT Ventures, talks about ADIT’s focus on late-stage growth companies, how they identify trends set to change the world and how they carefully select companies for their investment portfolio.

Show Highlights

In this episode, Eric and I talked about:

  • ADIT’s focus on late-stage growth companies affecting the most important secular trends.

  • How companies are taking longer to go public and value creation is happening more and more in the private markets.

  • How ADIT invests alongside their family office clients in every deal.

  • How ADIT sources investment opportunities.

  • The qualitative and quantitative screening process ADIT uses to ultimately qualify their investments.

  • Why good governance is good business.

  • The most important thing a late-stage company should do before reaching out to ADIT.

Quotes/takeaways

  • “…there’s a much more robust private market network than there was 10 years ago. Perhaps as much as ten times the amount of capital available for companies. And so I think that’s a major trend. “

  • “…really what we’re trying to do is capture these long-term secular trends that are profoundly changing our society, our world, our economy and our own capital markets that we talked about a few minutes ago. And those long-term trends, things like artificial intelligence, big data, cyber security, the cloud, the internet of things, the shared economy, digital healthcare, quantum computing, all of these things, the new media, virtual reality, altered reality, all of these things have been concepts and terms, almost like watching the Jetsons cartoons but there now actually really happening in society.”

  • …maybe the next 10 years will be better than the last 10 years because there’s so much potential to become realized and because people are aware of some of the challenges we’re facing, be it about sustainability or the environment or governance or some of the other issues, which are really material to us. But we’re super excited about the decade ahead. It’s gonna be a really exciting time to be an investor, to be a citizen of the world and to watch some of the potential to become realized.”

  • “…companies, when they do go public, they want to be at a critical mass, and they want to have a bullet-proof kind of story. We’ve seen that trend accelerate recently with much more of a value focus versus the growth-at-any-cost approach that we’ve had in the years past.

  • “We have a 5-year life in our typical portfolio and we like to get paid while we wait. So it’s an interesting process for us. It’s always challenging, it’s always a lot of fun, but it does require us to look and say no a lot. I think individual investors need to do their work and understand that, yes, you need to have a 3-5 year time horizon in the private markets. There is no free lunch. If someone’s offering you instantaneous, overnight success, look hard at that and question those assumptions.”

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Interview Transcript

December 2019, Eric Munson, Chief Investment Officer, Founder, ADIT Ventures

JB: Welcome to Hedge Interview. I’m your host Jennifer Bruno, and today I’m speaking with Eric Munson.

Eric is the co-founder and chief investment officer of Adit Ventures, a family office owned late-stage, venture firm based in New York with offices in the San Francisco Bay area.

Eric co-founded ADIT Ventures in 2014 at the request of family offices seeking to obtain shares in late-stage, venture backed growth companies. His family office owns equity in more than 20 privately-held companies.

With 35 years of investment industry experience, Eric has worked in alternative asset management, corporate finance, mutual funds, private equity, venture capital and growth equity. He has created, developed and managed over 20 funds while raising assets in excess of $20Billion.

Eric has served on the executive, investment and management committees at reputable firms including Hembrecht & Quist, Morgan Stanley, Franklin Templeton, Seneca, Wentworth Hauser & Violich and Acorn Partners. He has invested as a principal in more than 40 privately held companies, he has worked on 250 IPO’s and hundreds of other deals.

Thank you so much for joining me today Eric

EM: Thank you Jennifer. It’s a pleasure to be here.

JB: Thanks. I understand that collaboration and co-investment is a growing trend among family offices. Tell us how that trend played into the formation of ADIT Ventures.

EM: Really, ADIT Ventures developed as an outgrowth of my family’s investment practices. We started purchasing shares in privately held businesses, when we realized that much of the value creation was happening when companies were still privately held rather than in the public markets. When I started my career at Hembrecht & Quist, many, many years ago, much of the value of [a] company was being created in the public markets. They would go public at a modest, small capitalization of two or three hundred million. As their products became more accepted and their revenues increased, the valuation of the company would increase and the public market investors participated in that value creation. Today, companies are taking much longer to go public – 7, 8, 10, 12, 15 years in some cases – and so much of that value creation is happening in the private markets as the venture capital, growth equity markets have evolved.

JB: Do you think that waiting period, the pre IPO period, has extended, because there’s so much more investment opportunity beforehand, instead of the public markets?

EM: Well, I think there’s a couple of reasons for it. Yes, there is a lot more capital in the private markets than there was even 10 years ago. You can look at the growth in the New York venture capital community as examples of that. There’s tremendous amounts of growth in the private capital markets, be it for early stage, be it for B, C, D rounds and middle stages or later stages where we typically invest. So that’s part of the reason. The other part of the reason is that, companies, when they do go public, they want to be at a critical mass, and they want to have a bullet-proof kindof story. We’ve seen that trend accelerate recently with much more of a value focus versus the growth-at-any-cost approach that we’ve had in the years past. So I think when companies do, in fact, go public, companies like Alibaba going public 6-7 years ago, they had a very strong business model with very robust revenue growth and very strong fundamentals. In that sense, they were ready for prime-time in the public markets and were able to withstand the scrutiny. And I think more companies are waiting longer to do that.

JB: What has changed in the dynamics of capital markets that’s allowed them to obtain more capital pre-IPO?

EM: Well, you’ve seen a tremendous increase in the number of venture capital firms and the amount of capital invested in venture capital. You’ve seen a tremendous amount of increase in the monies invested in other alternative assets, private equity, buy-out funds, alternative lending strategies, so there’s a much more robust private market network than there was 10 years ago. Perhaps as much as ten times the amount of capital available for companies. And so I think that’s a major trend. I think that companies are staying ‘stealth’ longer and not having to disclose all of their proprietary technologies, their customers, their revenues, their earnings, and (they) are therefore able to hopefully surprise the competition and be able to come out of the blocks and be very effective in terms of executing their business models.

JB: It’s interesting, you know, for those of us with a few decades of experience in the financial markets to see the financial markets mature in certain ways and see how things evolve. Having been involved in the hedge fund industry, it has evolved tremendously in 20 years, so it’s equally interesting how the venture capital markets have evolved as well in this way. So, how does being a family office investor make ADIT different from other VC firms?

EM: Well, we like to look at the table as being a round table. It goes back to your first question, how do people work together and we really like to work with other families, many of whom bring an expertise in certain areas, industries, geographies. We have families from all over the world who invest along-side us. But one of the things that we’ve retained is the fact that we make it a round table and we invest in every single deal we do, my partners and I, right along-side their family investor partners on the identical same terms and conditions. So, we eat our own cooking. We make sure that we’re constantly looking at what we’re doing and it’s very important for us. The majority of our net worth is tied up in our deals, in our investments in our firm and we try to treat every investor and every client company frankly as part of our extended ADIT family. We take it very seriously and I think that’s a really important differentiator than many of our other competition. We’re not just trying to make a transaction happen here. We actually invest in the stock, we live with that stock, we live and breathe, we publish quarterly reports on it, every single news article that comes out about Palentier, about SpaceX, about AirBnB. Those articles come to us, we then put them up on our website. We publish quarterly commentaries, monthly sometimes if there’s a lot of news happening on a particular company, and try to share that information and knowledge with all of our investor partners. And we also lean on them for ideas and investment themes. That’s the way we try to communicate and share our ideas and there’s not a lot of firms who do that in our space of the late-state companies.

JB: I would think that being a family office, or evolving from a family office, that your relationships with your fellow investors must be deeper and different in that sense from other VC firms. You would have, I would guess, longer standing relationships with the investors that you co-invest with.

EM: Yeah, it’s an interesting part of the model in the sense that we’re working with people, having been in the business now since the 80’s, my partner as well, many, many years. It’s really a pleasure to work with people who you’ve known and now we’re actually even working with their children in some cases, the next generation. In some cases three generations of families and it’s really nice because you get different perspectives from different generations. You know the Millennials and the GenX’ers, may have a different approach than the Baby Boomer generation does, and the patriarchs of some of these families may be again, 20 or 30 years older, and they also have a unique perspective on investing, on the trends we’re seeing. ADIT sort of begins our process…one of the questions you’d asked me previously is how do we begin the process of finding our kinds of companies, and really what we’re trying to do is capture these long-term secular trends that are profoundly changing our society, our world, our economy and our own capital markets that we talked about a few minutes ago. And those long-term trends, things like artificial intelligence, big data, cyber security, the cloud, the internet of things, the shared economy, digital healthcare, quantum computing, all of these things, the new media, virtual reality, altered reality, all of these things have been concepts and terms, almost like watching the Jetsons cartoons but there now actually really happening in society. We’re going to have autonomous vehicles driving people around here. You know, it’s happening right now in selected markets in the United States. It’s going to be happening all over the world in the next quarter or two. Drone deliveries were simply a fantasy out of a science fiction novel, are actually occurring right now. You’ve got autonomous vehicles right now, operating mines for BHP Billiton, and they’re taking the raw materials from the quarries into the crushers. And the people who used to drive the trucks are now almost like playing video games operating these trucks autonomously. The digital healthcare things that are happening. If I unfortunately have some kind of a malady, the doctors can then take my cells, examine my blood type, examine my digital DNA characteristics and identify the things that I need. They’ll take some cells out, mix up some other things in those cells, re-inject them into my body and help my body heal itself, rather than taking an outside chemical, or chemotherapy or radiation therapy, things like that. So, there are so many things that are happening across society, across so many sectors of the economy. And we think we’re at a really exciting point in terms of change, in terms of the potential actually being realized for companies being more productive, individuals being more efficient, being able to experience things and interact with computers and all the data points for getting and use this technology, be it AI, or machine learning or deep learning and apply that in their lives be it in the security of their home and their family, be it in security of their digital data, be it in the productivity of their everyday lives in terms of getting to and from work or getting information out about their firms or their businesses or their services they are providing. So we’re really excited about the opportunities ahead. I think we’re gonna see..and most people, conventional wisdom is that the last 10 years have been so great, it’s the fourth best decade of investments in history, and oh my gosh, the world is coming apart because there’s too many people, there’s population pressures, there’s environmental pressures, the economy, things like that. We take the opposite view, that maybe the next 10 years will be better than the last 10 years because there’s so much potential to become realized and because people are aware of some of the challenges we’re facing, be it about sustainability or the environment or governance or some of the other issues, which are really material to us. But we’re super excited about the decade ahead. It’s gonna be a really exciting time to be an investor, to be a citizen of the world and to watch some of the potential to become realized.

JB: There are so many interesting developments. So, how did you choose those particular themes: Big Data, AI, Healthcare, Shared Economy and New Media. You have so many new developments. How do you…is it a matter of that’s your specific area of expertise is in those particular themes? Why those in particular?

EM: We sort of feel that those themes get to the essence of the human experience, be it in society, be it in the geopolitical realm, be it in economic terms, be it in the quality of life. We think that these kinds of themes will really make an impact on people. There are a lot of other themes out there, you know the rise of blockchain technology and the crypto currencies. It’s very difficult for me to tell you today that I understand exactly enough about crypto currencies and the blockchain to tell you how to express that theme in your portfolio profitably. The challenge for us is to take those themes and understand how to express them in the portfolio, in ADIT’s portfolio, in your portfolio as one of our investor partners potentially, and have that portfolio positioned to show positive cashflow and ultimately a path to profitability in the next 2 to 3 years, which is our criteria for making an investment. And so the themes we’ve chosen really we think are long-term secular trends for 10 years or more. They could be multi-generational themes. The Cloud has been in place now for 20 or 30 years. The same people who were naysaying Jeff Bezos for putting money into AWS and Microsoft for spending money in the Cloud are now cheering them for the tremendous amount of profits it’s making. The Shared Economy theme has already begun to yield results for us. That’s was one of our first investments in Spotify, which we bought at $50 per share, and it did a direct listing at over $166 per share. The stock is still in the $150 range and the company continues to grow and evolve and get more and more audio visitors. It’s now sort of the vanguard of podcasts and that seems to be the next wave of information flow, the way people communicate about things. So the themes we chose really are long-term material themes that we think are sustainable, scalable and we think have the effect to really profoundly change society, the economy and the quality of life for people around the world. I think the world has changed since my father’s generation. He was a Harvard business school graduate with Peter Drucker’s mentality of the corporation does what’s right for shareholders. That was it. The business round table has now decided that it’s much more of a holistic environment in the world today. The businesses, yes, they need to be more responsive to shareholders and provide them information and good returns. They also need to be responsive to their customers, and provide their customers good services, ethical business practices and more importantly, they need to be sensitive to their community at large. The people, the places they work in, their employees, and be responsible stewards of capital and responsible stewards of business, which is why on our qualitative side of our process…we have a 10-step investment process. 5 steps of which are more qualitative in nature. Things like, is it a good business, do they have a good management team, is it operated in an ethical, sustainable fashion, with good governance, rules of governance. It has helped us stay out of investment opportunities that don’t have those kinds of principles and don’t have those characteristics, and it has allowed us to avoid a lot of mistake-, potential mistake-investments. We passed on WeWork seven different times. We passed on Juul on four different occasions. We passed on Draft Kings and Fan Duel and many, many other deals. We’ve made a total of 16 investments in our fund in our 6 years of operations, so we were very selective. We see thousands of deals every year and we’ve done 2 or 3 deals a year and we continue to be very selective. We think that’s one of the value adds we bring, because once we invest, and one of the things I learned from working with Sir John Templeton at Franklin is the only thing we really control is the price we pay when we enter the position. We don’t control the capital markets, we don’t control the IPO process or the direct listing process or the sale of the business, but we do think that by buying a good quality company at a fair price, that’s growing, on its way to profitability, we’ll end up generating a nice rate of return for ourselves as well as for our investor partners.

JB: And is that why you choose to focus specifically on late-state growth companies, because there’s time to see the maturation of these companies so that you can identify those characteristics that you’re looking for?

EM: Yes. It really came as an outgrowth of our own investing and we were trying to find companies when the question isn’t if they’re gonna make it. It’s when they get monetized, how much will it be worth? That’s the difference. We’re not waiting for an FDA approval to have a company be validated. We’re taking existing companies that are established business models, with established revenue streams, on their way to scaling up to very robust levels of profitability, good management teams, the ability to withstand competitive pressures. And essentially the data, we did some analysis on it, shows that we have a much lower failure rate. We don’t want to strike out. We’re not gonna hit the home runs that some of the earlier stage investors might, but we’re not going to have the same level of failure or strike outs in the portfolio. We don’t want to lose money. We basically want to provide people consistently quality companies that we think over time, typically our funds have a five year life, so over the 3 to 5 year period we’re trying to essentially get 3 times our invested capital back on each of our portfolio companies. We’ve done that successfully over the past 5 years, and I think that metric is still available, but it does take patience and it does take discipline in terms of what you buy, how you buy it and how long you have to be in the position. And there’s always challenges. The only guarantees in life, as you know, are death and taxes, but we do like robust companies. We do like companies that are disruptive and changing the world, and changing the way we look at business and the world. Companies like Spotify, or SpaceX or AirBnB are all characteristics of this kind of disruption, and disruption can be really good and profound. So some of the themes that we’re identifying, some of the newer themes that we’re identifying in the year ahead are focused on those kinds of things. Tremendous disruption in the educational space for example. Higher education is prohibitively expensive. There’s lots of disintermediation going on there and we think there’s real opportunity there. Space, the whole space industry – we’re seeing tremendous interest in the exploration of space, figuring out ways, not just for space tourism, but for manufacturing in space and rare earth minerals from space, and other kinds of opportunities to utilize another part of the universe to generate some interesting benefits to humans and other people, other citizens of the universe. So we’re really excited about those kinds of trends, and we think that over the long term, it’s like sailing with the wind at your back – it just makes the ship move along a little faster, and makes for a much more pleasant sail and hopefully a faster way to get to the end our destination on our journey to successfully returning capital to our investors with a multiple to it.

JB: So would you say that you’re able to avoid more risk by investing in late-stage companies?

EM: Yes. There’s no question. We’ve worked with Cambridge Associates and some of the other consulting firms like New England Pension Consultants and other folks, some of the people at the Oxford Saïd School of Business. Professor Tim Jenkins has done a lot of work. I’ve been in his courses and had the pleasure of working with those people, and they’ve defined…there’s definitely a lower risk element to later stage investing. There’s also potentially less upside return. You know, we’re not going to buy a biotech company that’s waiting for an FDA approval probably. It’s not going to be one of our core positions. It’s really sort of a tangential approach. We like companies that have mature business models that are growing rapidly, have the ability to scale that business model into ultimately different vertical opportunities. Palantir is a great example. They started with their data tools in the government sector. They were seeded by Intel Cube, the CIA’s venture capital arm. They went into financial services, they went into healthcare, they went into energy, into immigration reform, doing work for AirBus now in terms of logistics and parts and management of all the fleets around the world. So they’ve taken this data tool and expanded now into 8 or 10 different verticals across 5 or 6 major countries, and now the company is on it’s way to becoming a multi-billion dollar annual revenue with recurring revenues and we think it’s a really exciting story. We love watching our business models evolve and grow and mature and we think the companies, like AirBnB, which we expect to be a direct listing sometime next year, and Palantir, which we’re expecting a liquidity event in 2021, SpaceX we’re thinking ‘22, ‘23. As they grow and mature, they’re going to become really profound elements of our society and impact the way in which we live our lives.

JB: How do you source these companies? There’s so many to choose from. How do you identify the ones that you give your serious attention and interest to?

EM: That’s a great question. We spend a lot of time looking at a lot of companies. As I mentioned, we see thousands of opportunities every year. We have regular research meetings. We have a team internally of 8 people at ADIT, 2 on the west coast, 8 here in New York. We’ve grown substantially and continue to grow. We have an advisory board of 8 people as well, all around the globe. We have over 500 investor partners. We get ideas from all of those sources. Many of our best ideas come from our CEOs of our existing companies who are also seeing other entrepreneurial companies. But we really spend a lot of time identifying those themes and we typically start small and we take a long time to make a decision in any of the companies we’re investing in, and we really like to find new innovative companies that are off the radar. So we spend a lot of time on that. I would say that our typical company source, with one example is a company called Decision Sciences, which is a California-based company was referred to us from a former Fortune 500 CEO who is an investor partner of ours. I met the company about 4 years ago with his introduction and we’ve been a shareholder for the past 3 years. Decision Sciences uses naturally-occurring atomic particles to scan the back of containers, coming across our borders on trucks or coming into our ports. No X-ray, no radiation. Much more accurate, much more timely, and in fact we think they will end up with a virtual monopoly on the border crossings, the ports and all of our military bases in the United States as well as all the major ports around the world. These ideas are generated with science. They licensed the technology from Los Alamos Livermore Labs in New Mexico – the same people who created the nuclear bomb. They’re using this research to help find peaceful, productive, safe uses of these kinds of things. So, really we get ideas all over the world, all over the map. We’re looking at it on a global basis because even though I grew up in Silicon Valley…my father moved us from Brooklyn, New York to Silicon Valley to go work for the very first venture capital-backed company. In 1970 he went to go work for Fairchild Semiconductor, which begat Intel and AMD and National and really changed the way investments occurred around the United States and certainly with the venture capital community. We’re now seeing the same kind of innovation all over the world. Tremendous green shoots being opened up in Europe, in Latin America, in Southeast Asia. Singapore Monetary Authority for example is doing tremendous work incubating ideas and interesting companies over there. In the Middle East, some of the sovereign wealth funds in the UAE are also very, very aggressively incubating ideas. We see tremendous green shoots in cities like Berlin and all over Europe, and so often times the valuations of these companies in ‘non-mainstream’ cities are far, far lower than they are in New York and San Francisco or Seattle or San Diego. So we’re really excited about the global approach to it, and we’ll probably have a global offering down the road as well. In fact, many of our most successful investments, Spotify is a Luxemborg-based, Swedish music streaming service. Today we own shares in Klarna, the largest fintech company in Europe with a $5.5B valuation. We’ve been buying it now for almost a year and we’re really excited about that company, but again, it’s a Swedish company. It came to us through our network of family office relationships overseas, and we continue to see tremendous ideas from a lot of our foreign partners. So, I strongly encourage investors to come to the ADIT website. We’ve always got information being put up there about trends around the world. We have thought leadership publications, 10 different white papers on various topics, be it augmented reality or virtual reality or AI or big data or healthcare. And we’re publishing those things every month going forward as we can and provide people a lot of information, and we actually have an ongoing dialogue with people. We do a couple of events a year and we really welcome the feedback from people all over the world to give us ideas and thoughts about things to think about. It’s one of the things we really enjoy. It’s almost given me a renaissance of my investment career, because it’s hard to teach old dogs new tricks and this old dog gets to work with some really interesting young, innovative, entrepreneurial companies. Exciting! I sometimes feel like I’m drinking information out of a fire hose. It’s so much flow of ideas and thoughts and information, that it’s a challenge, but it’s also invigorating and stimulating. It’s one of the favorite things that I get to do every day is to think about the world, how it’s changing, how it’s evolving and the challenges we’re facing, and I talk to some of the most innovative, bright, capable, thoughtful people in the world, be it on the allocation side, be it on the company side, be it on the due diligence side, the risk management side. We’re really, really excited about the opportunities ahead and the everyday excitement of finding great companies with great entrepreneurs. It’s fun.

JB: I bet it is. But at the same time, you’re very disciplined. I mean, you’re invested in, I think, 15-20 companies, 20 companies? So it’s not that you’re throwing money at all of these wonderful, exciting new ideas. You’re very disciplined in your approach, so what makes you ready to allocate? When are you ready to pull the trigger and say, ‘let’s do this, let’s allocate now’?

EM: That’s a good question Jennifer. It’s a combination of factors. We have the qualitative measures I mentioned to you. We also have a series of quantitative measures, and on the quantitative side of things, we look for growth rates in terms of looking for scalable, sustainable growth. We want to see significant growth and we want to see the ability to sustain that growth and scale that growth across the globe. We also look for things like a clear path to profitability and positive cash flow, but we use a lot of alternative techniques to measure that. So, in the case of Spotify for example, when we first invested in Spotify, Apple Music hadn’t really launched yet and JZ’s title was thought to be a big threat and Spotify was in fact cashflow positive in its mature markets. They were still investing a lot of money in R&D to identify new channels, new countries of opportunity. What we did notice is the number of downloads of Spotify’s application were far greater than that of Apple Music or any of the other competitors, which gave us the confidence to understand that ultimately the free downloads would grow into paid subscribers and with enough free people, the ‘Freemium’ model to churn people, positive churn, to add subscribers over time, paid subscribers would be enough to sustain the growth rate. And we ended up doing quite well with that investment. The same kind of metrics we used with Lyft and we saw the number of Lyft’s downloads were far higher than some of their competitors, particularly when those competitors had some material bad news and some governance issues, and some misogynistic behavior and some issues related to how they treated their drivers. All of a sudden we became very comfortable and confident that Lyft would in fact outperform its larger competitors and once more, focused approach became clear to us. So we use a variety of different metrics to identify the timing. Ideally, we buy the company right as it’s beginning to scale in the J curve. The reason we buy, in many cases, about half the time we’re buying secondary shares, we want to shorten that J curve. Rather than owning it for seven years and then seeing the growth, we’d like to own it for seven or eight months and then see the growth, prior to a catalyst. That catalyst might be a growth equity round that gives them capital to go out and expand their marketing, go into new countries as Palantir has in Japan, as Spotify did by penetrating other markets, be it overseas or be it in Korea or Japan in Spotify’s case. So those are the kinds of things we look for. But it’s a combination of the qualitative and the quantitative values we bring to bear in conjunction with having the right price, the right cost basis to enter the transaction. Ideally we if we can buy the transaction at a slight discount, the last round, that gives us a margin of safety as our good friend Seth Klarman might say in his hedge fund. If we’re buying at a cheap enough price, we can wait for the value of the company to be compounded by their profitability, their growth rate, the future prospect for profits and higher growth rates in terms of revenues. So that’s sort of the combination. It’s a very subjective process, in terms of understanding management teams. We always meet with the management team, face to face. We go do a physical visit to their offices. We like to get to know the companies very, very well. We’re not often getting board seats. We don’t own control of these companies. We’re minority investors. We do demand information rights on the companies. Sometimes that’s formal, in terms of buying a Preferred share. Sometimes it’s an informal process, but we have to have information going in. Again, there’s no guarantees in life other than death and taxes, but if we have to have the facts and we’re able to share the facts with our investors, at least we’re going into the investment with our eyes wide open, and that’s the minimum requirement for us. We do think it’s very important to be disciplined though. We’re not going to be an index fund. We think there’s going to be big winners and there’s going to be some big dislocations and therefore some companies that will not be successful. I have, on my wall in my study at home, copies of stock certificates from A&P stores and from Chrysler corporation and from companies like Xerox and Kodak which were the highest tech, leading edge companies in their era and now don’t exist…or (they) are a fraction of their former selves in terms of what they have, in terms of proprietary technologies and business models. So it’s a very humbling experience to be at the vanguard of technology and services and emerging growth companies. You have to be nimble, you have to be honest, and humble and you have to work very, very hard and we work really hard to try to keep ourselves abreast of what’s happening in a lot of the trends. We’re speaking at over twenty conferences next year. We attend over 50 conferences. I’m on the road about a third of my time. I just got back from Europe, Nordic countries and the Middle East. I’m headed to Asia in the first half of next year and we travel extensively. We think that by getting that perspective from people around the world, it makes us better investors. By getting the hard questions from smart reporters like yourself and other journalists and other investors, it makes us better investors because they challenge our assumptions. We have to verify, confirm and rationalize the assumptions we’ve made, the decisions we’ve made and the premises we’re basing our themes on. That to us is a very helpful, albeit sometimes humbling process to make sure we’re doing things in a thoughtful, mindful, logical and hopefully, ultimately a successful fashion.

JB: You mentioned in your Q4 2019 IPO Market Update that, you said ADIT avoids companies that ‘don’t behave’, companies that are less responsible. So, how do you dodge the bullets that you’ve dodged? How do you avoid the bad apples?

EM: You know it’s, again, a very subjective process. We believe good governance is good business. Full stop. And buy companies that are good stewards. They represent their community. They support their customers, their employees and they make the world a better place in general. Those are the kinds of companies we want to be involved with. Alternatively, we don’t like to be involved in companies that are providing a good or a service that may or may not be a positive to the world. We felt very clearly that the FanDuel Draft Kings would be under severe regulatory scrutiny, and that gambling while it be a good revenue source potentially for the state of New Jersey or Nevada or ultimately it would be a kind of nationally-allowed sports gambling, it wasn’t necessarily an activity that we felt we should be embracing and endorsing. Not that we’re judging it, but in terms of making the world a better place, sports gambling or other kinds of gambling is not going to improve quality of life for people around the world. It might make the states some money and that might be helpful but not something that’s going to change society for the better. The same is true with the vaping company Juul. When we passed on that deal the first two times, and then Phillip Morris invested in the company, we left $14M on the table and my son made me aware of that when he told me we left $14M on the table. My mother passed away from lung cancer and symptoms of it and I just was not comfortable investing in a company that was trying to be healthier, and that was the spin that they were having on the vaping consumption business, for having tobacco but not smoking. I still didn’t feel that that was necessarily a huge contributor to society. Ultimately those health claims are what’s creating the backlash from regulators and I just think that’s an important discipline to have. Not that we’re morally taking the high road. The same thing could be true of companies that are not as environmentally friendly. They’re not focused on sustainable business practices. It makes good business sense to be focused on sustainability and on good governance in our opinion. I rewrote the Sierra Club’s legal defense fund investment policy statement, now almost 35 years ago. Before when they were given stock from some of their doners, they would just sell the companies and walk away, almost like an ostrich putting its head in the sand. I made the case to the board, look that’s one way to go. You can sell those companies and divest them and focus on the companies that are the good actors, or alternatively, you can embrace the system. As a shareholder of Exxon or Chevron, you can put your shareholder initiatives on the ballot and therefore have a voice to be an activist and help the company to understand that you want them to change their behavior. And I think it’s very clear now that society wants companies to change bad behavior. And as a consequence, they’re going to punish those companies in terms of rules and regulations but more importantly in terms of a valuation on the business. The market is already discounting the bad actors, bad governance, bad practices. By doing that, we think we’re focusing on good practices and better companies will get better valuations because of these principles of being environmentally sustainable and sound, by having sustainability practices across their entire ecosystem and more importantly having good governance rules. So, as they meet regulatory challenges, competitive challenges, have to deal with conflicts that inevitably occur in a business between providing for your employees, providing for your community and providing for your shareholders, there’s a process to understand every part of the equation and do the right thing. So, it’s not easy. So it’s not easy to be a CEO these days. We get that. But we also think it’s important and there’s a responsibility there that’s not just about the corporation making maximum profits and everyone taking their money away and living happily ever after. There’s an element these days of making the world a better place which we think is a very important part of any investment process.

JB: So, would you say that those corporate governance factors are what help you build trust in a company, regardless of what you think about the founder or specific people. Would you say that’s how you build trust in an organization is those factors? How do you build trust in a company?

EM: That’s a great question. Building trust with a management team and trusting in the company’s business model is a very complex and involved process. Our typical due diligence process gets us through the initial part of it, but on of the most important things is the values of the CEO and of the board and of the company. By having shared values, things that are important on a global macro kind of approach, it allows us to meet the individual challenges, whatever they may be, in business, in society, with your employees, with your community, with environmental issues, with sustainability issues, maybe. By having overall shared values, we get more comfortable with the process. There’s always going to be challenges in any business. They have to pivot. Facebook had challenges, Google had challenges, Apple computer almost went bankrupt a couple of times in its history. I had the pleasure of working on the Apple IPO way back when, and I’ve seen the company go up and down. And obviously, the company today is one of the largest market cap companies in the world, if not the largest market cap company, but they had to pivot several times. Every business has to make tough decisions. If they use their shared values in aggregate as a board, as a team of executives, as a business, those shared values send a message to the investment community, to their customer base and to the overall world that you’re this kind of company, and we want to focus on the companies that are trying to make the world a better place, trying to make their businesses more efficient, more profitable, more sustainable, more focused on serving their customers, their clients, their employees as well as their community at large. And that holistic approach, I think, and those shared values, are what helps us build an understanding and a trust in the management team and the business. One of the reasons we passed on Uber was the fact that we didn’t feel the governance was very strong. Now, they’ve got a new management team in place. They are in the process I think of changing that culture and making it a much better business model and a much better company. But it’s a very large business and it’s going to take them years to turn that around as it has so far. We chose Lyft because it had better governance and it was the first one to do employee benefits, training, provide childcare, to do the carbon offset footprint on all of their rides. It’s now become industry standard to do many of those things. Tipping for their employees – that was a Lyft innovation. So we are very comfortable with the values that that management team put forth. We are comfortable and trust that they will be executing towards profitability at a far better pace than their larger competitors around the world. So that’s the reason we made those decisions, so yes, we definitely focus on those kinds of shared values to enable us to have a level of trust in the management team and it’s very important to us.

JB: What’s a common mistake that these late stage growth companies make in the process of trying to attract additional capital?

EM: Well I think a lot, there’s mistakes that the companies make and there’s mistakes that investors make when they try to select those companies. We’ll talk a little about both if we could. The companies themselves often times get into what I call a process of “di-worsification.” They might have a really nice business model here and they they get a wild idea. In the case of Lyft and Uber, their idea of ‘let’s own scooter companies, lets buy the bike companies to buy that last mile of connectivity.’ Those companies in those industries, the scooter business, the bike business, while they’ve been around for a while, they’re not commercially viable. They’re far earlier in their genesis than the ride sharing business which could be traced back to taxis and chariots back in the Roman days for that matter. Ride sharing has been going on for a long time, just like AirBnB’s lodging model. Having people sleep on your couch or share a guest bedroom has been around for thousands and thousands of years. What’s changed in the ride sharing businesses Lyft and to a lesser extent Uber have figured out ways to use GPS and other technology to make it much easier for you and I to get a taxi or a ride from here to there and much more affordable. We think that the principles of those ideas are really important. I think getting excited about those kinds of spaces is really important. I think for a lot of reasons, we avoid the problem issues because of those kinds of disciplines we bring to the process.

JB: You’ve probably reviewed thousands of pitches. What are the ones that stand out to you? What impresses you?

EM: Well, I think you have to have a clear, concise story. You need to be able to tell the story in a matter of minutes, frankly. You can look at a business and understand the basic tenets, 3, 4, 5, 6 things that make you unique and special, what you bring, your edge in terms of what you can do that other people can not, what you do which is proprietary, what you think is important, the values you bring to the business, to the economy, to the marketplace, to the community at large, and those are the kinds of things that have to resonate for us. We’ve seen a lot of people get distracted with jargon words: cloud, cyber, AI, machine learning, blah, blah, blah, but as they say in Texas, “there’s all hat and no cattle.” We want to see the cattle. “Where’s the beef?” as Clara Peller said way back when on the Burger King ads. We want to see ‘where’s the beef’. What’s their secret sauce to have their product, their service, their whatever it may be, resonate with consumers, resonate with customers, resonate with their employees, resonate with the community at large, be it the investment community, the venture community or the public markets at large. Those are really important concepts and really important things and it’s surprising how often people get distracted. I was talking to a gentleman who had a really cool technology related to blockchain on super secure communications, and he kept going off about this crypto currency token that he had done six years ago related to the business and I said look, I understand you did this transaction six years ago on your business, but the crypto currency token has nothing to do with your core technology capabilities and in fact your business model going forward because that token was six years ago. Your future is ahead in this encrypted technology. Focus on the story. Oftentimes we get all wrapped up and it’s the holiday time, so everyone looks at the package, how it’s wrapped, rather than what’s inside the package and how to utilize the toy, the sweater, whatever, the food in the package, whatever it might be. So we like to get through the packaging and get down to the core, essential element of what the service or the good is of the particular company. And oftentimes, companies make mistakes by diffusing their  messaging, by wrapping it in too many kinds of wrappers to appeal to people. Right now there’s this massive amount of money going after green investing and ESG and many of the people who are leading those funds do not have the qualifications to be good investors, and they’re wrapping themselves in that (ESG) blanket just to attract assets rather than really do the work and really make sustainability and ESG principles or whatever principles they’re using a primary driver. They really just using it as a marketing tool. We want to avoid those kinds of ‘hype’ situations. Oftentimes, the mistakes that investors make, they justify the largest cap companies across any marketplace and assume these are the big guys and they’re gonna be successful. That doesn’t work. It didn’t work for WeWork, it didn’t work that that well for Uber. It has not worked historically for things. You need to figure out the right companies to buy and the right price to buy them at. It’s not rocket science, although we do own some rocket science companies. In fact, we put that into our documents. The last sentence in one of our SpaceX documents is, “There can be no assurances that management of ADIT nor of the target company, SpaceX, will achieve its objectives because after all, this is in fact, rocket science. And, there are no guarantees, but we think that people like what who are smart and work hard and are relentless in their approach, will ultimately overcome the challenges, overcome the failures and be successful in putting astronauts back in space and potentially using space to mine rare earth minerals or manufacture things in a clean room environment without gravity. These are the kinds of applications that we think have far-reaching consequences and ultimately will drive the valuation of SpaceX and other satellite and space-related companies much much higher over time.

JB: So, to go back for just a second. The comment you made about market capitalization. Would you say that’s the biggest thing investors overestimate? What do they underestimate in the process of reviewing late-stage companies, typically, that you see?

EM: I think that investors really need to understand the business model. They need to do the homework. There’s no shortcuts in life. In my opinion, life is about hard work. It’s about struggle, it’s about the human spirit overcoming adversity and challenge. That’s true in an individual’s life, that’s true in a student’s life, it’s true in a baby’s life, it’s true in an investor’s life. It’s true in a company’s life. Every company has to overcome adversity and failure. We mentioned a number of them like Apple and Amazon and Google, Facebook. Some of the largest companies in the world have faced existential challenges in their lives, but by being able to have the values that they did, bring the management team together to overcome those challenges, be it competitive challenges, technological challenges, societal challenges, regulatory challenges – to be able to overcome those challenges. Investors need to differentiate the hype between the facts. They need to have realistic assumptions about what the growth rate of the company might be, what the penetration of the good or service may be across different marketplaces and understand that companies need to invest capital to grow their businesses and that it’s not an instantaneous payout. This is not putting a chip on red and getting paid every time the bell rings. Sometimes it works, sometimes it doesn’t. Companies that are well managed and well-governed have a better chance of being consistently successful in growing their business and investing in their businesses, investing in their employees, investing in their partners. But I think investors need to focus on the facts and right now there’s a tremendous amount of misinformation in the world about companies. One of the advantages in the privately held marketplace is that there is a distinct informational edge. Those people who have the information, we like to follow those folks who are the top-quartile performing venture capital managers. We look at a lot of early stage investment flows to understand where the smart money is allocating capital. Much like people follow Warren Buffet in the public markets, we follow the smart money in the private markets. What we found, thanks to Tim Jenkins and many other people at Oxford, is that there is a persistence of repeatable, top-quartile results among a certain number of these top-quartile venture managers, about a dozen firms we follow. That persistence does not exist in any other asset class – not in hedge funds, not in mutual funds, not in long-only managers, not in buy-out funds, not in other private equity asset classes but in venture capital there’s a group of managers that have the right ecosystem, they have enough capital, they have the right HR people, enough pool of executives. They have enough resources at those firms to identify the trends, the market places and the companies to back, and they’ve got a consistent 20-30 year track record of doing that. We like to follow that smart money and allocate our monies to those kinds of names as they get to be more successful. We like to do it, rather than in 10-15 years, try to do it in 3-5 years in our portfolio. We have a 5-year life in our typical portfolio and we like to get paid while we wait. So it’s an interesting process for us. It’s always challenging, it’s always a lot of fun, but it does require us to look and say no a lot. I think individual investors need to do their work and understand that, yes, you need to have a 3-5 year time horizon in the private markets. There is no free lunch. If someone’s offering you instantaneous, overnight success, look hard at that and question those assumptions. Look at the downside risk. We like to have asymmetrical returns, we like to follow the smart money venture investors and some select corporate venture capital investors which have become very very large in the last decade or so. The rise of corporate venture capital is a trend we are speaking on at a number of conferences going forward. They are oftentimes 30-40% of these rounds and they can become the exit strategy. In fact, 70% of our positions we expect to be purchased by a strategic investor or another acquirer of some sort who’s looking for that growth to be incorporated into their business model. There’s a trillion and a half dollars in dry powder in venture capital right now. That money needs to be put to work. You’re going to see more and more deals taken from one sponsor to another. We’ve seen that happen already in the saas (software as a service) space with Vista Equity Partners and Thoma Bravo being very active in the space. Multiple $3B-$5B deals happening all over the map and right now we think M&A is going to drive things going forward and perhaps even more so than the IPO market for the next decade ahead. Because you’ve got low interest rates, low cost of capital a need to grow the businesses and put up some sustainable growth rates and more and more firms we think are going to be doing that going forward.

JB: What role does transparency play at this stage of the game when you’re looking at late stage growth companies? Are they fairly transparent to you when communicating to you about some of the hurdles that they have to overcome? If they say, “We’ve encountered X, here’s how we’re dealing with it.” Is that typical or not typical?

EM: It really depends on the company. I would say transparency is essential for us to have some level of transparency. At a minimum, we get financial information about the company and their business. Sometimes it’s delayed three months or six months from the typical board meeting. We don’t need to have it in real time. We’re not trying to micro-manage the business. As long as we have access to information, it gives us enough information to make good investment decisions on the company. And to allow us to share that information on an as-needed basis with our investor partners. That’s essential for us. I think that companies who are transparent, who do communicate well with the investment community, with their customer base, with their shareholders are better governed and we think therefore are more attractive to us and ultimately we think will become more valuable as investments to us. So in that kind of approach, we think transparency is essential. Most companies have a mixed bag on transparency. They want to provide some information, but they also want to keep part of what they’re doing secret because they’re still privately held and they want to have a competitive edge against some of their other folks, and so it’s an interesting process. Transparency is an essential step for us, yes.

JB: What’s the number one thing you would advise a late-stage company to do before they contact or present to you?

EM: Well, for us we need to have a general understanding of their business. We’d like for them to present to us information in a concise, professional, clear fashion, we’d like to have some transparency on the financials, on their board on their cap table and on their plans going forward. What ADIT does before we make any investments, we create our own 5-year pro-forma financial, do our own projections on a business and make sure that we’re comfortable with those things going forward. That’s an essential part of our process, so we need to get that kind of information in our hands and really understand how they will challenge the conventional wisdom, the conventional market opportunities and how they’ll respond to competitive challenges going forward – margin pressure, inflationary pressures, cost of capital, what their decision might be on a public offering or a sale of the business. Those kinds of important, strategic decisions are very important for us to understand, their values and their thought process behind having to manage those things. That’s sort of the beginning of establishing some level of trust in a management team to execute on their strategy on their vision. Ultimately the vision that they have and the capability of the team to execute that vision is what defines success, in my opinion of a growth company.

JB: Right, that’s very important. Lastly, what are you looking forward to next year or as we approach the new year?

EM: You know, I’m super excited about the year ahead. We have the mobile phone platform, with our little hand-held computer. We think we’re going to be into a whole new paradigm and shift. You’re seeing now with the advent of the 5G networks, of the machine learning tools and all the big data tools gathering information to actually make artificial intelligence and deep learning, machine learning stuff, actually become very helpful and mainstream for us in our daily lives. Be it traffic patterns or financial information or other kinds of things, we think that AI and augmented reality and virtual reality will be hugely prevalent in the decade ahead. I think the whole concept of computers serving us and us being able to use voice actuation. I mean, with all due respect to Siri and Alexa and some of the current technologies, how many times have you talked to Siri and asked her a question and you get no response or the wrong response. We can’t really rely on her at this point, nor Alexa. But I think in the next decade ahead, we will be doing a lot more with facial recognition, eye recognition or voice recognition and it’ll be much easier. Instead of having the DOS commands that were so difficult for people to learn or other computer languages, computers will be there to serve us, the data tools will be there to serve us. We think there’s going to be tremendous interest still in cybersecurity. Probably the next kind of terrorist attacks we’re going to see are not going to be nuclear bombs or people blowing up buildings with planes, but cyberterrorism is probably a much more likely source. I think you’ll see tremendous changes in the healthcare system, in the transportation system, in the use of energy and the management of the energy grid and industries like logistics. When you’ve got bills of lading, you know major ships coming into ports. Instead of being digitized, it’s pieces of paper with a 25 ton ship coming into a dock in a port. My god, let’s get some digital records here and understand what’s in there. So all of these kinds of industries that have been in the dark ages and have not been digitized and organized and logistics, and transportation and energy. All of these kinds of things we think have tremendous changes ahead. Healthcare is almost 30% of the economy. There’s going to be profound changes in our whole economic system. So I’m really excited about the decade ahead. I think you’re going to see people be pleasantly surprised by a lot of the near term catalysts. I think ultimately there is a moral compass, and I think the globe is going to be a better place ten years from what it is today and people will feel more confident and more in control because of the information tools they have, because of the data they pull and understand, and because of the tools they’ll have to understand things going forward. We are really very optimistic about the names in our portfolio and about a lot of things going forward. I’m really optimistic and really excited about the new decade ahead and can’t wait to see what happens. I look forward to having a conversation again with you a year from now, two years from now, five years from now, to look back and see some of the things we’re talking about. I will be releasing our quarterly letter the week of January 16, 2020 with our ten surprises in the decade ahead, potential surprises. So, I’ll be happy to share those ideas with you later on in the year ahead.

JB: Great, I look forward to that. And you’re so right. It’ll be amazing to see what develops in the coming year and in the next decade. It’s amazing how quickly things do develop. So yeah, there’s a lot to look forward to. Thank you so much for your time today Eric. I appreciate all of your insights.

EM: My pleasure.

JB: Those capital seekers out there will get a good understanding of what’s important today as far as attracting capital.

EM: Absolutely. The only constant is change, so happy investing, have a wonderful holiday, happy new year and we’ll see you in the decade ahead.

JB: Ok, thank you so much Eric.

EM: Thank you Jennifer. Take care.

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